When you’re running a business, one of the key decisions you’ll make is how to pay yourself.
Whether you’re a sole trader, limited company director, or partner in a business, getting the balance right between remuneration and keeping your business financially stable is crucial.
Let’s explore the best ways to pay yourself, outline key considerations, and provide tax-efficient strategies so you can make informed decisions about your personal and business finances.
Don’t have time? Here’s the wrap-up of this article in less time it takes to eat a taco 🌮
▪ Choose between salary and dividends if you’re a limited company director for tax efficiency.
▪ Sole traders and partnerships can take drawings from business profits but must manage tax and business expenses.
▪ Pay yourself from profits, not revenue, to ensure your business stays financially healthy.
▪ Always budget for taxes, maintain an emergency fund, and plan for long-term financial security.
▪ Separate personal and business finances, and track your income and expenses for better clarity and compliance.
▪ n.b. Stay Sharp, Stay Savvy and Keep Winning.
Show Me The Money! Paying Yourself as a Small Business Owner
1- Why Understanding How to Pay Yourself Matters?
For many small business owners, figuring out how to pay yourself is more complex than simply withdrawing money.
It depends on your business structure, tax implications, and how much to reinvest in your business for growth. From choosing whether to take an owner’s draw or salary to understanding tax bills, every decision impacts your personal and business finances
2- How to Pay Yourself from a Limited Company
As a director of a limited company, you have more control over your remuneration compared to a sole trader. You can split your earnings between salary and dividends, which can be a tax-efficient way to minimize tax liabilities while maximizing take-home pay.
▪ Salary:
Pay yourself a reasonable salary—typically up to the tax-free personal allowance, which is £12,570 for the 2024-2025 tax year. This salary level is below the National Insurance Contributions (NIC) threshold, meaning no income tax or employee NICs are payable.
Employer NICs will still be payable at 13.8% for earnings above £9,100. But this salary is deductible for Corporation Tax, saving you money.
▪ Dividends:
Dividends are paid from post-tax business profits. While you can’t count them as a business expense when calculating Corporation Tax, they benefit from lower tax rates compared to salary.
The first £500 in dividends is tax-free for the 2024-2025 tax year. After that, the dividend tax rate starts at 8.75%, which is lower than income tax rates on salary.
You can pay dividends as frequently as you like, giving flexibility, but be mindful not to pay dividends exceeding the company’s profits, as it could lead to tax penalties.
This combination of salary and dividends allows for efficient tax planning. Many business owners pay themselves a salary up to the personal allowance and take the rest in dividends to reduce tax liability.
3- Paying Yourself as a Sole Trader or in a Partnership
If you’re a sole trader or in a partnership, paying yourself is a little different. Instead of taking a salary, you withdraw drawings from the business. This means you’re taking profits directly from the business for personal use, but taxes are not automatically deducted.
▪ Drawings:
Unlike limited company directors, sole traders and partners withdraw business profits as personal income. This gives you complete control over when and how much to take out.
Self-employed individuals pay taxes on profits through the Self-Assessment system, so you’ll need to track your income carefully to ensure accurate tax reporting.
▪ Taxes:
Be prepared for income variance and budget for taxes. National Insurance and income tax are not deducted automatically, so it’s a good idea to set aside 25-30% of your profits for tax payments.
Remember, the more you take as drawings, the less money you leave in the business for cash flow and growth, so balance is key.
4- Budgeting for Taxes and Emergencies
Regardless of your business type, it’s crucial to plan ahead for tax obligations and unexpected expenses.
▪ Set Aside for Taxes:
A good rule of thumb is to save at least 25-30% of your business income in a dedicated business bank account for taxes.
If you’re a sole trader or in a partnership, paying your Self-Assessment tax bill at the end of the year can be a shock if you haven’t budgeted properly.
▪ Maintain an Emergency Fund:
Always leave enough funds in the business for running costs and to act as a buffer during tough times.
Consider building an emergency fund that covers at least 3-6 months of expenses, both personal and business-related.
▪ Plan for Retirement:
Don’t forget your future. Make pension contributions from your business income, and if you’re a director, you can also benefit from tax relief by making pension contributions through the company.
5- Separating Personal and Business Finances
One of the most important things any business owner can do is to keep personal and business finances separate. Keep business records separate.
Here are a few key reasons
▪ Simplifies Accounting:
Using a separate business bank account ensures clarity between personal expenses and business expenses. And it’s much easier to track income and expenses for tax purposes, and it helps avoid confusion at year-end when calculating profits.
▪ Financial Stability:
Having a clear division between personal and business money keeps the business financially stable, which is crucial for long-term success.
Conclusion – Maximising Your Earnings as a Business Owner
Choosing the best way to pay yourself depends on your business structure and goals. Whether you’re a sole trader who withdraws drawings from business profits or a limited company director balancing salary and dividends, being tax-efficient is key.
By following these steps—setting aside taxes, maintaining an emergency fund, and keeping your business and personal finances separate—you can ensure long-term stability for your business while maximizing your personal earnings.
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